Banks, Mars, and Venus

The proposed Foreclosuregate settlement reveals a chasm between the banks and the rest of us.

Federal and state regulators are considering a $20 billion settlement with banks over the Foreclosuregate scandal. Remember Foreclosuregate? During the housing bubble, lenders may have neglected to secure or convey properly to mortgage securitizers legally required documentation on home loans, and after the housing bust, the banks hired "robo-signers" to sign hundreds of foreclosure-related documents a day without actually reading or checking them. Now the feds want the banks to fork over $20 billion to reduce the principal amounts that homeowners owe on their mortgages, a settlement intended to encompass both appropriate punishment and practical redress. The divergent reactions to the $20 billion figure from banks, on one hand, and consumer groups, on the other, vividly demonstrate how, three years after the economy cratered, lenders continue to view the world in a radically different way than most other people.

The proposed settlement, I should point out, is an awfully long way from a done deal. Those who are involved aren't disclosing details, because there are no details to disclose. The banks certainly haven't committed to anything. And the Obama administration, according to several sources, is divided on the proposal. Word is that the $20 billion figure comes from Elizabeth Warren's Consumer Financial Protection Bureau (an agency whose function, at this early stage, is entirely advisory), and that other federal regulators aren't necessarily onboard. Republicans in Congress are trying to quash existing foreclosure prevention programs, not start a new one. As for President Obama, he's pulled in two opposite directions. A few years ago, he told the American public that his foreclosure prevention efforts would help up to 9 million borrowers. So far, they've helped only a small fraction of that number. That makes a new program politically convenient. But since the midterm elections Obama has been trying to position his administration as pro-business. Forcing a hefty settlement on the banks would not be seen as pro-business.

The basis of the proposed settlement—and a significant source of rage against the big banks—is their legally questionable foreclosures. After news broke this past fall about the robo-signers, and about how sometimes the banks created fraudulent documents to hide their negligence, federal regulators and state attorneys generals began investigating and some big banks were forced to suspend foreclosures. (Whether the earlier process of turning mortgages into securities was so corrupted by faulty record-keeping that loan servicers now lack the right to foreclose at all is not part of the settlement discussions; one knowledgeable source tells me it is being dealt with separately.) But the real source of the rage against the banks encompasses everything from the banks' reluctance to modify mortgages to keep people in their homes to the basic truth that it was the banks that invented and pushed flawed mortgage products in the first place. Jon Maddux, the CEO of the Web site You Walk Away, which counsels people to do just that regardless of whether they can or can't pay their mortgages, admits that borrowers made mistakes. But "lenders did it thousands and thousands of times, and made billions of dollars" doing it.

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The deep anger toward the banks explains why people like George Goehl, the executive director of National People's Action, which is coordinating with thousands of homeowners, are arguing that $20 billion is a mere pittance and that nothing short of criminal prosecution of senior level bankers would be acceptable. One financial services analyst tells me it's absurd for anyone to talk about a settlement when there are grounds for prosecution for "just the sheer amount of crap" banks have done. "Banks should be given a choice," he says. "Either be part of a solution that is much bigger than $20 billion, or face prosecution that could destroy them." Or try a sampling of readers' comments on any story about the housing market. This one is from the New York Times Web site: "No excuses should be accepted for the irresponsible and predatory manner in which these iconic American institutions behaved."

The worldview of the banks couldn't be more different. They say they're being scapegoated. What about the homeowners who took out mortgages they couldn't afford? As for Foreclosuregate: The banks have repeatedly described their mistakes as "technical" in nature and argue that those who lost their homes deserved to do so anyway. As Citigroup said in a recent filing, "the integrity of its current foreclosure process is sound and there are no systemic issues." Or as Bank of America CEO Brian Moynihan reportedly said, as many as 80 percent of foreclosure sales in the second quarter of 2010 involved borrowers who had not made a single payment during the previous year. This view has found some support in the results of an investigation by the Office of the Comptroller of the Currency and other regulators. In recent testimony, acting comptroller John Walsh cited "critical deficiencies" that have "resulted in violations of state and local foreclosure laws," but he also said that only a small number of borrowers had been improperly foreclosed upon. (Skeptics counter privately that the OCC wasn't allowed to do a real investigation.)

The banks also give another reason for not wanting to pay the $20 billion: It won't work. It will be too difficult, they say, to figure out who should get a reduction in loan principal, and the promise of such reductions could cause even more people who can afford to pay their mortgages to embrace Maddux's philosophy and just walk away. As Stifel, Nicolaus research analyst Christopher Mutascio wrote in a recent report: "Who gets the principal reductions … anyone underwater? The thought process is puzzling to us. The banks erred in the foreclosure process on consumer A. Thus, consumer B receives a principal reduction? How do you connect the dots on that?"

And, anyway, the banks argue, the number of mortgages that could be saved with $20 billion in principal reductions is too small to matter. Think about the numbers. According to a First American Logic study, when the value of a home falls below 75 percent of what the borrower owes on the mortgage, the homeowner begins to think about walking away. First American said that it would cost about $745 billion, slightly more than the Bush administration's TARP bailout of all the banks, to rescue all the underwater borrowers. Another way of doing the math is that $20 billion could reduce by $100,000 each the balance on 200,000 mortgages. But right now, there are at least 2.2 million homes in foreclosure. Of course, a settlement many times larger than $20 billion that would make a difference. But if that number threatens the stability of the banking system, aren't we right back to the fall of 2008?

Another practical consideration concerns Fannie Mae and Freddie Mac. Once government-sponsored and now government-owned, Fannie and Freddie encouraged robo-signing in order to process foreclosures quickly, because doing so helped them reduce their own losses, thereby reducing the losses to taxpayers. Edward DeMarco, who is the acting director of the Federal Housing Finance Agency, recently sent a letter to Shaun Donovan, the secretary of the Department of Housing and Urban Development, arguing that reducing the principal on mortgages would cost taxpayers money. Given that, how should any settlement handle the huge volume of mortgages that are guaranteed by Fannie and Freddie?

When I consider the banks' arguments, I'm torn.

On the one hand, they lack any moral standing. While they don't deserve 100 percent of the blame for the mess—anyone who lived beyond her means needs to look in the mirror—they managed to shift responsibility for the cleanup onto taxpayers. The banks' arguments that their violations against homeowners are only technical reveals contempt for their customers. Convicted criminals get better treatment. And one of the smartest people I talk to has argued repeatedly that the government—or the banks themselves—should have spent some of the money that was eventually spent on TARP to bail out homeowners back in 2007, and then we would never have had a foreclosure crisis.

But there may be some validity to the banks' practical arguments. It's too late to turn the clock back to 2007. And mortgage modifications that don't work aren't just ineffective. They are harmful, both to the economy and to the borrower. Keeping someone in a house he or she can't afford can be viewed as just another form of predatory lending.

What should alarm everyone, including the banks, is that the banks don't reside on the same planet as most taxpayers and consumers. Isn't it Business 101 that something has gone terribly wrong when those who are supposed to be your customers start to hate, fear, and distrust you?